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MANAGERIAL
ECONOMICS
Study material
COMPLEMENTARY COURSE
For
I SEMESTER B
...
School of Distance Education
CONTENTS
MODULE
PARTICULARS
PAGE
NO
...
B
...
B
...
Economics is a social science
...
It
deals with aspects of human behavior
...
The development of economics as a growing science can be traced back in the
writings of Greek philosophers like Plato and Aristotle
...
Actually economics broadened into a full fledged social science in the
later half of the 18th century
...
Hence a plethora of definitions are available in connection with the subject
matter of economics
...
B
...
D
...
Wealth Definition
Really the science of economics was born in 1776, when Adam Smith published his famous book
“An Enquiry into the Nature and Cause of Wealth of Nation”
...
According to him, economics is the study of wealth- How wealth is
produced and distributed
...
But this definition was severely criticized by highlighting the points like;
Too much emphasis on wealth,
Restricted meaning of wealth,
No consideration for human feelings,
No mention for man‟s welfare
Silent about economic problem etc…
B
...
By his classic work
“Principles of Economics”, published in 1890, he shifted the emphasis from wealth to human welfare
...
He
adds, that economics “is on the one side a study of the wealth; and the other and more important side, a
part of the study of man”
...
Prof
...
This definition clarified the scope of
economics and rescued economics from the grip of being called “Dismal science”, but this definition
also criticized on the grounds that welfare cannot be measured correctly and it was ignored the valuable
services like teachers,lawyers,singers etc (non-material welfare)
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C
...
According to him, “Economics is the
science which studies human behavior as a relationship between ends and scares means which have
alternative uses”
...
Unlimited wants- In his definition “ends” refers to human wants which are boundless or
unlimited
...
Scarcity of means (Limited Resources) – the resources (time and money) at the disposal of a
person to satisfy his wants are limited
...
Alternate uses of Scares means- Economic resources not only scarce but
have
alternate uses also
...
4
...
Hence we need to arrange wants in the order of urgency
...
But this also criticized on the grounds that; it is
too narrow and too wide, it offers only light but not fruit, confined to micro analysis and ignores Growth
economics etc
...
Modern Definition
The credit for revolutionizing the study of economics surely goes to Lord J
...
He defined
economics as the “study of the administration of scares resources and the determinants of income and
employment”
...
Samuelson recently given a definition based on growth aspects which is known as Growth
definition
...
Economics analyses the costs and the benefits of improving patterns of resources
use”
...
Meaning and Definition of Managerial Economics
...
S
...
Joel Dean observed that managerial Economics shows
how economic analysis can be used in formulating policies
...
Firstly, it provides number of tools and techniques to enable the manager to become more
competent to take decisions in real and practical situation
...
According to Prof
...
It seeks to establish rules and principles to facilitate the attainment
of the desired economic aim of management
...
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Spencer and Siegleman defined managerial Economics as “the integration of economic theory with
business practice for the purpose of facilitating decision making and forward planning of management”
managerial economics helps the managers to analyze the problems faced by the business unit and to take
vital decisions
...
They have to choose
that course of action by which the available resources are most efficiently used
...
In the words of Michael Baye,”Managerial Economics is the study of how to direct scares
resources in a way that mostly effectively achieves a managerial goal”
...
The other objectives are:
1
...
3
...
5
...
7
...
To integrate economic theory with business practice
...
To allocate the scares resources in the optimal manner
...
To minimize risk and uncertainty
To helps in demand and sales forecasting
...
To help to achieve the other objectives of the firm like industry leadership, expansion
implementation of policies etc
...
Managerial economics provides help in this area
...
2
...
4
...
6
...
It provides tool and techniques for managerial decision making
...
It supplies data for analysis and forecasting
...
It guides the managerial economist
...
It assists the management to know internal and external factors influence the business
...
b) Selection of suitable product mix
...
d) Product line decision
...
f) Decision on promotional strategy
...
h) Allocation of resources
...
j) Make or buy decision
...
l) Decision on export and import
...
n) Capital budgeting
...
B
...
Scope of Managerial Economics is
wider than the scope of Business Economics in the sense that while managerial economics dealing the
decisional problems of both business and non business organizations, business economics deals only
the problems of business organizations
...
Managerial economics giving solution to the problems of non profit
organizations like schools, hospital etc
...
The scope covers two areas of decision making (A)
operational or internal issues and (B) Environmental or external issues
...
They pertains to simple questions of what to produce, when to produce, how
much to produce and for which category of consumers
...
1
...
3
...
5
...
Demand analysis and Forecasting: - The demands for the firms product would change in response
to change in price, consumer‟s income, his taste etc
...
A
study of the determinants of demand is necessary for forecasting future demand of the product
...
The factors causing
variation of cost must be found out and allowed for it management to arrive at cost estimates
...
Pricing Decisions: - The firms aim to profit which depends upon the correctness of pricing
decisions
...
Theories regarding price
fixation helps the firm to solve the price fixation problems
...
But
firms working under conditions of uncertainty
...
Capital budgeting: - The business managers have to take very important decisions relating to the
firms capital investment
...
Success of the firm depends upon the proper analysis of capital
project and selecting the best one
...
Production analysis is proceeds in physical terms while cost analysis proceeds in monitory term
...
A study of economic
environment should include:
1
...
3
...
5
...
The types of economic system in the country
...
Magnitude and trends in foreign trade
...
Government economic policies viz
...
B
...
Managerial economists have to study
external and internal factors influencing the business while taking the decisions
...
2
...
4
...
...
Following are the important specific functions of managerial
economist;
1
...
2
...
3
...
Economic analysis of competing industry
...
Investment appraisal
...
Security management analysis
...
Advise on foreign exchange management
...
Advice on trade
...
Environmental forecasting
...
Economic analysis of agriculture Sales forecasting
The responsibilities of managerial economists are the following;
1
...
3
...
5
...
7
...
To make accurate forecast
...
To keep the management informed of all the possible economic trends
...
To participate in public debates
To earn full status in the business team
...
Following are the important feature of managerial economics
1) Managerial economics is Micro economic in character
...
2) Managerial economics largely uses the body of economic concepts and principles which is
known as “Theory of the Firm” or “Economics of the firm”
...
It is purely practical oriented
...
4) Managerial economics is Normative rather than positive economics (descriptive economics)
...
5) Macro economics is also useful to managerial economics since it provides intelligent
understanding of the environment in which the business is operating
...
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Managerial economics as a tool for decision making and forward planning
...
Perhaps the most
important function of the business manager is decision making
...
Resources such as land, labour
and capital are limited and can be employed in alternative uses, so the question of choice is arises
...
Manager
has to choose best among the alternatives by which available resources are most efficiently used for
achieving the desired aims
...
2
...
4
...
6
...
The statement of the problem to be solved
...
Evaluation and analysis of alternatives
...
Following are the important areas of decision making;
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
k)
l)
m)
n)
Selection of product
...
Selection of method of production
...
Determination of price and quantity
...
Optimum input combination
...
Replacement decision
...
Shut down decision
...
Location decision
...
Forward Planning: -Future is uncertain
...
Risk and uncertainty can be minimized only by making accurate forecast and forward
planning
...
A manager has to make plan for the future e
...
Expansion of existing
plants etc
...
The knowledge of various economic theories
viz, demands theory, supply theory etc
...
So managerial economics enables the manager to make plan for the future
...
B
...
Economics
Managerial Economics
1
...
Dealing both micro and macro aspects
2
...
2
...
3
...
3
...
Study the problems of firm only
...
Study both the firm and individual
...
Narrow scope
...
Wide scope
Self check questions
...
(Weightage-1/4)
1
...
is known as the „father of economics”
...
Welfare definition of economics is given by……………
...
The scarcity definition is suggested by………
...
…………… bridges the gap between traditional economic theory and real business practices
Short answer type (Weightage -1)
1
...
3
...
5
...
Define managerial economics?
What is the difference between business economics and managerial economics?
What is scarcity definition?
What you mean by decision making?
What is forward planning?
What is economic problem?
Short essay type (Weightage -2)
1)
2)
3)
4)
Define Managerial economics? What are its basic characteristics?
What are the responsibilities of managerial economist?
What is decision making? What are its elements or steps?
Distinguish between economics and managerial economics?
Essay type (Weightage -4)
1) Define Managerial economics? Explain the scope of managerial economics?
2) Explain role and functions and responsibilities of managerial economists?
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MODULE II
DEMAND CONCEPTS
Meaning of Demand
Demand is a common parlance means desire for an object
...
In economics „Demand‟ means the quantity of goods and services which a
person can purchase with a requisite amount of money
...
Hidbon, “Demand means the various quantities of goods that would be purchased per
time period at different prices in a given market
...
Simply, demand is
the behavior of potential buyers in a market
...
In other words, demand means the desire backed by the
willingness to buy a commodity and purchasing power to pay
...
There
must have necessary purchasing power, ie,
...
For example, everyone desires to posses
Benz car but only few have the ability to buy it
...
Thus the demand has three essentials-Desire, Purchasing power and Willingness to purchase
...
The demand analysis includes the study of law
of demand, demand schedule, demand curve and demand forecasting
...
To measure the elasticity of demand
...
To increase the demand
...
Law of demand shows the relation between
price and quantity demanded of a commodity in the market
...
According to Samuelson, “Law of Demand states that people will buy more at lower price and
buy less at higher prices”
...
So the relationship described by the law of demand is an
inverse or negative relationship because the variables (price and demand) move in opposite direction
...
The concept of law of demand may be explained with the help of a demand schedules
...
The following table shows the demand schedule of an individual consumer
for apple
...
B
...
)
demanded
10
1
8
2
6
3
4
4
2
5
When the price falls from Rs 10 to 8, the quantity demanded increases from one to two
...
On the basis of the above demand schedule we can
draw the demand curve as follows;
The demand curve DD shows the inverse relation between price and demand of apple
...
This kind of slope is also
called “negative slope”
Market demand schedule
Market demand refers to the total demand for a commodity by all the consumers
...
It can be expressed in
the following schedule
...
Price per
Demand by consumers
dozen(Rs)
A
B
C
D
Market
Demand
10
1
2
0
0
3
8
2
3
1
0
6
6
3
4
2
1
10
4
4
5
3
2
14
2
5
6
4
3
18
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Derivation of market demand curve is a simple process
...
When the price of one dozen eggs is Rs
...
When price falls to Rs
...
When
price falls to Rs
...
By adding up the
quantity demanded by all the four consumers at various prices we get the market demand curve
...
They are as follows
1)
2)
3)
4)
5)
6)
7)
There is no change in consumers‟ taste and preference
Income should remain constant
...
There should be no substitute for the commodity
...
The demand for the commodity should be continuous
...
Why does demand curve slopes downward?
Demand curve slopes downward from left to right (Negative Slope)
...
Therefore the consumer is willing to pay only lower prices for additional units
...
If it is not equal, they will alter their purchases till the marginal utility is equal
...
B
...
When the price of the commodity falls, the real income of the consumer will increase
...
4) Substitution effect
...
Therefore the consumer will substitute this
commodity for coffee
...
5) Different uses of a commodity
...
If the price of the commodity is high, its use will be
restricted only for important purpose
...
g
...
When it is cheaper, it will be used for preparing jam, pickle etc
...
Psychologically people buy more of a commodity when its price falls
...
7) Tendency of human beings to satisfy unsatisfied wants
...
(Exceptional Demand Curve)
...
But there are some exceptions to this
...
e
...
These
phenomena may due to;
1) Giffen paradox
The Giffen goods are inferior goods is an exception to the law of demand
...
When the price of maize falls, the poor will not
buy it more but they are willing to spend more on superior goods than on maize
...
This paradox is first explained by Sir Robert Giffen
...
According to Veblen, rich people buy certain goods because of its social distinction or prestige
...
Hence
higher the price of these articles, higher will be the demand
...
Some times consumers think that the product is superior or quality is high if the price of that
product is high
...
4) Speculative Effect
...
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5) Fear of Shortage
...
6) Necessaries
In the case of necessaries like rice, vegetables etc
...
7) Brand Loyalty
When consumer is brand loyal to particular product or psychological attachment to particular
product, they will continue to buy such products even at a higher price
...
In certain occasions like festivals, marriage etc
...
Exceptional Demand Curve (perverse demand curve)
When price raises from OP to OP1 quantity demanded also increases from OQ to OQ1
...
Hence,
demand curve (DD) slopes upward
...
It may increase or decrease due to changes in certain factors
...
These factors include;
1)
2)
3)
4)
5)
6)
7)
Price of a commodity
Nature of commodity
Income and wealth of consumer
Taste and preferences of consumer
Price of related goods (substitutes and compliment goods)
Consumers‟ expectations
...
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Demand Function
...
I
...
, a change in any
determinant will affect the demand
...
Demand function of a commodity can be written as follows:
D = f (P, Y, T, Ps, U)
Where, D= Quantity demanded
P= Price of the commodity
Y= Income of the consumer
T= Taste and preference of consumers
...
Demand may change due to various factors
...
A change in
demand solely due to change in price is called extension and contraction
...
On the other hand, when the
quantity demanded falls due to a rise in price, it is called contraction of demand
...
When the price of commodity is OP, quantity demanded is OQ
...
When price rises to P1, demand decreases from OQ to OQ1
...
As result of
change in price of a commodity, the consumer moves along the same demand curve
...
, it is called shift in demand
...
On the other hand, if the consumers buy
fewer goods due to change in other factors, it is called downward shift or decrease in demand
...
The increase and decrease in demand
(upward shift and downward shift) can be expressed by the following diagram
...
B
...
Demand curve shift upward due to change in income, taste &
preferences etc of consumer, where price remaining the same
...
Comparison between extension/contraction and shift in demand
SL
...
remaining the same
...
Joint demand:
When two or more commodities are jointly demanded at the same time to satisfy a particular want, it is
called joint or complimentary demand
...
Composite demand:
The demand for a commodity which can be put for several uses (demand for electricity)
Direct and Derived demand:
Demand for a commodity which is for a direct consumption is called direct demand
...
When
the commodity is demanded as s result of the demand of another commodity, it is called derived
demand
...
Industry demand and company demand:
Demand for the product of particular company is company demand and total demand for the products of
particular industry which includes number of companies is called industry demand
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ELASTICITY OF DEMAND
Meaning of Elasticity
Law of demand explains the directions of changes in demand
...
But it does not tell us the rate at which demand changes to change in
price
...
This concept explains the
relationship between a change in price and consequent change in quantity demanded
...
Elasticity of demand can be defined as “the degree of responsiveness in quantity demanded to a
change in price”
...
There are mainly three types of elasticity of demand:
1
...
2
...
and
3
...
Price Elasticity of Demand
Price Elasticity of demand measures the change in quantity demanded to a change in price
...
This can be measured
by the following formula
...
There are five types of price elasticity of demand
...
1) Perfectly elastic demand (infinitely elastic)
When a small change in price leads to infinite change in quantity demanded, it is called perfectly
elastic demand
...
(Here ep= ∞)
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2) Perfectly inelastic demand
In this case, even a large change in price fails to bring about a change in quantity demanded
...
e
...
Here demand curve will be vertical line as follows and ep= 0
3) Relatively elastic demand
Here a small change in price leads to very big change in quantity demanded
...
A large change in price
leads to small change in demand
...
B
...
When both are equal, ep= 1, the
elasticity is said to be unitary
...
3 Income Elasticity
of Demand
Income elasticity of demand shows the change in quantity demanded as a result of a change in
consumers‟ income
...
2) Negative income Elasticity
3) Positive income Elasticity
...
ie, changes in the income doesn‟t influence the quantity demanded (Eg
...
Here
Ey (income elasticity) = 0
Negative income elasticity -In this case, when income increases, quantity demanded falls
...
Here Ey = < 0
...
B
...
i
...
, when income rises, demand also rises
...
i
...
i
...
I
...
, Ey = <1
Business decision based on income elasticity
...
A
businessman can rely on the following facts
...
Firms whose demand functions have high income elasticity have good growth opportunities in an
expanding economy
...
Cross Elasticity of Demand
Cross elasticity of demand is the proportionate change in the quantity demanded of a commodity in
response to change in the price of another related commodity
...
Examples of substitute commodities are tea and coffee
...
Cross elasticity of demand can be calculated by the following formula;
Cross Elasticity = Proportionate Change in Quantity Demanded of a Commodity
Proportionate Change in the Price of Related Commodity
If the cross elasticity is positive, the commodities are said to be substitutes and if cross elasticity is
negative, the commodities are compliments
...
Complementary goods (car and petrol) have negative cross elasticity because increase in the price
of car will reduce the quantity demanded of petrol
...
For fixing the
price of product which having close substitutes or compliments, cross elasticity is very useful
...
B
...
This can be measured by
the following formula;
Advertisement Elasticity = Proportionate Increase in Sales
Proportionate increase in Advertisement expenditure
...
Type of commodity- elasticity will be higher for luxury, new product,
growing product etc
...
Market share – larger the market share of the firm lower will be promotional elasticity
...
Rival‟s reaction – if the rivals react to increase in firm‟s advertisement by increasing their own
advertisement expenditure, it will reduce the advertisement elasticity of the firm
...
State of economy – if economic conditions are good, the consumers are more likely to respond to the
advertisement of the firm
...
It helps to deciding the optimum
level of advertisement and promotional cost
...
Hence, advertisement elasticity helps to decide optimum advertisement
and promotional outlay
...
The concept of elasticity of demand is much of practical importance;
1
...
Hence elasticity of demand helps to fix the level of output
...
Price fixation- Each seller under monopoly and imperfect competition has to take into account the
elasticity of demand while fixing their price
...
3
...
For
example, if the demand for labour is inelastic, trade union can raise wages
...
International trade- This concept helps in finding out the terms of trade between two countries
...
5
...
In order to impose tax on a
commodity, the government should take into consideration the demand elasticity
...
Nationalization- Elasticity of demand helps the government to decide about nationalization of
industries
...
Price discrimination- A manufacture can fix a higher price for the product which have inelastic
demand and lower price for product which have elastic demand
...
Others- The concept elasticity of demand also helping in taking other vital decision
Eg
...
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Determinants of elasticity
...
This is due
to influence of various factors
...
Nature of commodity- Demand for necessary goods (salt, rice,etc,) is inelastic
...
2
...
But the goods which have no substitutes, demand is inelastic
...
Extent /variety of uses- a commodity having a variety of uses has a comparatively elastic
demand
...
Demand for steel, electricity etc
...
Postponement/urgency of demand- if the consumption of a commodity can be post pond, then it
will have elastic demand
...
5
...
E
...
Rich man will not curtail the
consumption quantity of fruit, milk etc, even if their price rises, but a poor man will not follow it
...
Amount of money spend on the commodity- where an individual spends only a small portion of
his income on the commodity, the price change doesn‟t materially affect the demand for the
commodity, and the demand is inelastic
...
Durability of commodity- if the commodity is durable or repairable at a substantially less amount
(eg
...
8
...
9
...
10
...
, are other important factors affecting elasticity
...
Following are the important
methods:
1
...
It is also known as formula method
...
OR
=
Change in Demand
Original Quantity demanded
Change in Price
Original price
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2
...
Under this method,
the elasticity is measured by estimating the changes in total expenditure as a result of changes in
price and quantity demanded
...
If the price changes, but total expenditure moves in the opposite directions, demand is elastic
(>1)
...
This can be expressed by the following diagram
...
Geometric or Point method: This also developed by Marshall
...
In this method we
can measure the elasticity at any point on a straight line demand curve by using the following
formula;
ED = Lower section of the Demand curve
Upper section of Demand curve
...
Further
it is assumed that AB is 6 cm
...
5/1
...
5/4
...
B
...
Arc Method: the point method is applicable only when there are minute (very small) changes in
price and demand
...
It is a measure of the
average elasticity According to Watson,” Arc elasticity is the elasticity at the midpoint of an arc
of a demand curve”
...
Q1= original quantity
Q2= new quantity
∆P= change in price
Fill in the blanks
...
--------- means the degree of responsiveness of demand to the changes in price
2
...
3
...
Tea and coffee are…………
...
car and petrol are……………
...
2
...
4
...
What you mean by elasticity?
What is price elasticity?
What is income elasticity?
What is cross elasticity?
What is promotional elasticity?
Short essay type (Weightage -2)
1
...
What is the importance of the concept of elasticity?
3
...
What is elasticity of demand? State the determinants of elasticity?
2
...
(Weightage-1/4)
2
...
4
...
6
...
8
...
Demand has three essentials-Desires+ Purchasing power +……………
...
Is known as the „first law in market”
...
relationship
...
means relationship between demand and its various determinants expressed
mathematically
...
The demand changes due to changes in other factors, like taste and preferences, income, price of
related goods etc… , it is called ……………
...
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Short answer type (Weightage -1)
1
...
2
...
4
...
6
...
discuss various determinants of demand?
2) Explain and illustrate shift in demand, extension and contraction of demand and make a
comparative study?
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DEMAND ESTIMATION AND FORECASTING
Demand Estimation
Business enterprise needs to know the demand for its product
...
The
current demand should be known for determining pricing and promotion policies so that it is able
to secure optimum sales or maximum profit
...
Demand Estimation is the process of finding current values of demand for various values
of prices and other determining variables
...
Identification of independent variables such as price, price of substitutes, population,
percapita income, advertisement expenditure etc
...
collection of data on the variables from past records, publications of various agencies etc
...
Development a mathematical model or equation that indicates the relationship between
independent and dependant variables
...
Estimation of the parameters of the model
...
e
...
5
...
Tools and techniques for demand estimation includes;
1
...
2
...
Market Experiment
...
Statistical techniques
...
Accurate demand forecasting is essential for a firm to enable it to produce the required quantities at
the right time and to arrange well in advance for the various factors of production
...
Demand Forecasting refers to an estimate of future demand for the product
...
It is essential to distinguish between forecast of demand
and forecast of sales
...
Demand forecast relate to production inventory control, timing, reliability of forecast etc
...
Macro level – Micro level demand forecasting is related to the business conditions prevailing
in the economy as a whole
...
Industry Level – it is prepared by different trade association in order to estimate the demand
for particular industries products
...
It is useful for interindustry comparison
...
Firm level – it is more important from managerial view point as it helps the management in
decision making with regard to the firms demand and production
...
B
...
Based on the time span and planning requirements of business firms, demand forecasting can be
classified into short term demand forecasting and long term demand forecasting
...
Important purposes of Short term Demand forecasting are given below;
1
...
3
...
Making a suitable production policy to avoid over production or underproduction
...
Deciding suitable price policy so as to avoid an increase when the demand is low
...
A high
target may discourage salesmen
...
Forecasting short term financial requirements for planned production
...
Evolving a suitable advertising and promotion programme
...
The important purpose
of long term forecasting is given below;
1
...
2
...
3
...
4
...
Demand forecasting is a vital tool for marketing management
...
It enables the firm to produce right quantities at right time and
arrange well in advance for the factors of production
...
All these methods can be grouped
into survey method and statistical method
...
Under this method, information about the desire of the consumers and opinions of experts are
collected by interviewing them
...
Opinion Survey method: This method is also known as Sales- Force –Composite method or
collective opinion method
...
This method is more useful and appropriate because the
salesmen are more knowledgeable about their territory
...
Expert Opinion: Apart from salesmen and consumers, distributors or outside experts may also be
used for forecast
...
make use of outside experts for
estimating future demand
...
3
...
Under this method, a
panel is selected to give suggestions to solve the problems in hand
...
Panel members are kept apart from each other and express their
views in an anonymous manner
...
B
...
Consumer Interview method: Under this method a list of potential buyers would be drawn and each
buyer will be approached and asked about their buying plans
...
This may be undertaken in three ways:
A) Complete Enumeration – In this method, all the consumers of the product are interviewed
...
Sample may be
random sampling or Stratified sampling
...
Statistical Methods
1
...
3
...
5
...
In this method, statistical and mathematical techniques are used
to forecast demand
...
This includes;
Trent projection method: Under this method, demand is estimated on the basis of analysis of past
data
...
Here we try to ascertain the
trend in the time series
...
Regression and Correlation: These methods combine economic theory and statistical techniques of
estimation
...
) is ascertained
...
Extrapolation: In this method the future demand can be extrapolated by applying binomial
expansion method
...
Simultaneous equation method: This means the development of a complete economic model which
will explain the behaviour of all variables which the company can control
...
This is done with the help of statistical and economic indicators like:
Construction contract,
Personal income
Agricultural income
Employment
GNP
Industrial production
Bank deposit etc…
Forecasting Demand for a New Product
...
1
...
3
...
5
...
Evolutionary Approach: In this method, the demand for new product is estimated on the basis of
existing product
...
g
...
Substitute Approach: The demand for the new product is analyzed as substitute for the existing
product
...
Opinion Polling Approach: In this approach, the demand for the new product is estimated by
inquiring directly from the consumers by using sample survey
...
Vicarious Approach: Consumers reactions on the new products are fount out indirectly with the
help of specialized dealers
...
B
...
The following are the important factors governing demand forecasting:
1
...
,
2
...
3
...
(Plant capacity, quality, important policies of the firm)
...
Factors affecting Export trade (EXIM control, EXIM policy, terms of export, export finance etc
...
Market behaviour
6
...
)
7
...
Competitive Condition (competitive condition within the industry)
Criteria for Good forecasting Method
...
Plausibility-It should be reasonable or believable
...
Simplicity- It should be simple and easy
...
Economy – it should be less costly
...
Accuracy – it should be as accurate as possible
...
Availability –Relevant data should be easily available
...
Flexibility – it should be flexible to adopt required changes
...
AR= TR/Q
Total Revenue (TR):
TR means the total sales proceeds
...
TR =PxQ
Incremental Revenue (IR):
IR measures then differences between the new TR and existing TR
IR=R2-R1 =∆R
Marginal Revenue (MR);
It is the additional revenue which would be earned by selling an additional unit of a firm‟s
products
...
MR= R2-R1/Q2-Q1 = ∆R/∆Q
Where, R1= TR before price change
R2= TR after price change
Q1 = old quantity before price change
Q2 = new quantity after price change
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The relationship between AR, TR and MR can be understand with the help of the following table
Quantity
demanded
AR
TR
MR
(Q)
1
2
3
4
5
6
7
8
9
9
8
7
6
5
4
3
2
1
9
16
21
24
25
24
21
16
9
9
7
5
3
1
-1
-3
-5
-7
The study of the above table reveals that:
1
...
MR falls more steeply than AR
3
...
Where MR is negative, TR will be falling
5
...
The relation between elasticity of demand and TR can be summarized as under:
Change in price
Rises in price
Fall in price
Elasticity
...
=1
TR unchanged
TR unchanged
Elasticity <1
TR rises
TR falls
Incremental Revenue is the change in total revenue irrespective of changes in price
...
it rather measures the the effect of managerial decision on
total revenue
...
(Weightage-1/4)
1
--------- Is an “objective assessment of the future course of demand”
...
Vicarious approach is meant for the forecasting of ………
3
...
is the base of marketing planning
...
What is demand estimation?
3
...
What are the levels of forecasting?
5
...
What are the factors affecting demand forecasting?
2
...
What are the criteria for ideal forecasting method?
Essay type (Weightage -4)
1
...
Define demand forecasting? How it different form demand estimation? Explain its
objectives?
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MODULE III
PRODUCTION
Introduction
In Economics the term production means process by which a commodity(or commodities) is
transformed in to a different usable commodity
...
) into an output
...
The production process however does not necessarily involve physical conversion
of raw materials in to tangible goods
...
For example , production of legal, medical ,social and consultancy services- where lawyers,
doctors, social workers consultants are all engaged in producing intangible goods
...
Fixed and variable inputs
...
Therefore, all of its users cannot buy more of it in short run
...
If one user buys more of it, some other users will get less of it
...
All the users of such factors can employ larger quantity in the short run
...
A firm has two types of production function:(1) Shot run production function
(2) Long run production function
Production function
Production function shows the technological relationship between quantity of out put and the quantity of
various inputs used in production
...
In other words, It is the tool of analysis which is used to explain the input - output
relationships
...
in its
specific tem it presents the quantitative relationship between inputs and output
...
Fixed input or fixed factors
...
Variable input or variable factors
...
g
...
Thus an increases in production during this period is
possible only by increasing the variable input
...
The long run refers to a period of time in which “ supply of all the input is elastic ; but not
enough to permit a change in technology
...
Thus in the long run, production of commodity can be increased by employing
more of both ,variable and fixed inputs
...
It can be expressed algebraically as;
Q=f (K,L etc)
...
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The production functions are based on certain assumptions;
1
...
Limited substitution of one factor for the others
3
...
Inelastic supply of fixed factors in the short run
Cobb-Douglas Production Function
...
The concept was originated in
USA
...
The cob-Douglas formula says that labour
contributes about 75% increases in manufacturing production while capital contributes only 25%
...
L is the quantity of labour „C‟ is the quantity of capital employed K and
a(a<1)are positive constants
...
The production function shows at One (1%)percentage change in labour, capital remaining constant, is
associated with 0
...
Similarly One percentage change in capital, labour remaining
constant, is associated with a 20%change in output
...
That is if factors of
production are increased, each by 10 percentage then the output also increases by 10 percentage
The laws of production
Production function shows the relationship between a given quantity of input and its maximum
possible out put
...
This kind of relationship yields the law of
production The traditional theory of production studies the marginal input-output relationship under
(I) Short run; and (II) long run
...
The Law of production under these assumptions are
called “ the Laws of variable production”
...
The long-run input output relations are studied under `Laws of Returns to
Scale
...
By definition certain factors of production (e
...
-Land, plant, machinery etc) are available in
short supply during the short run
...
In short-run there fore ,the firms can employ a limited or
fixed quantity of fixed factors and an unlimited quantity of the variable factor
...
This kind of change in input combination leads to variation in factor proportions
...
The variation in inputs lead to a disproportionate increase in output more and more units of
variable factor when applied cause an increase in output but after a point the extra output will grow
less and less
...
The Law states that when some factor remain constant
,more and more units of a variable factor are introduced the production may increase initially at an
increasing rate; but after a point it increases only at diminishing rate
...
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The following table explains the operation of the Law of Diminishing Returns
...
of
Total
Average
Marginal
Workers
product
product
product
1
10
10
10
2
22
11
12
3
36
12
14
4
52
13
16
5
66
13
...
7
10
7
82
11
...
5
3
9
85
905
0
10
83
8
...
With one
variable input
...
Average product is the product for one unit of labour
...
It is found out by dividing the change in total product by the
change in the number of workers
...
The rate of increase in the marginal product reveals this
...
The
maximum marginal product is 16 after which it continues to fall , ultimately becoming negative
...
The graphical representation the above table is shown below
Stage 1
Stage 2
Stage 3
Y
TP
Output
AP
MP
O
X
No
...
B
...
The total
output(TP)curve has a steep rise till the employment of the 4th worker
...
TP curve still goes on
increasing but only at a diminishing rate
...
The Law of Diminishing Returns operation at three stages
...
The marginal product at this stage increases at an increasing rate
resulting in a greater increases in total product
...
This stage
continues up to the point where average product is equal to marginal product
...
At the second
stage , the total product continues to increase but at a diminishing rate
...
The second stage comes to an end
where total product become maximum and marginal product becomes zero
...
So the total product also declines
...
Assumptions of Law Diminishing Returns
The Law of Diminishing Returns is based on the following assumptions;Returns is based on the following assumptions;1
...
The variable factor is homogeneous
...
Any one factor is constant
4
...
Law of Returns to scale
In the long –run all the factor of production are variable ,and an increase in output is possible
by increasing all the inputs
...
The law of returns of scale explain how a simultaneous
and proportionate Increase in all the inputs affect the total output
...
If the increase in output is
proportionate to the increase in input , it is constant Returns to scale
...
The increasing returns to the scale comes first ,then constant and
finally diminishing returns to scale happens
...
Marginal output increases at this stage
...
Constant Returns to scale
Firms cannot maintain increasing returns to scale indefinitely after the first stage , firm enters a stage
when total output tends to increase at a rate which is equal to the rate of increase in inputs
...
Diminishing Returns to Scale
In this stage ,a proportionate increase in all the input result only less than proportionate increase in
output
...
When the firm grows further,
the problem of management arise which result inefficiency and it will affect the position of output
...
B
...
Increasing returns to scale operates because of economies of scale and
decreasing returns to scale operates because of diseconomies of scale where economies and
diseconomies arise simultaneously
...
overweight the economies of scale
...
When a firm increases all the factor of production it enjoys the same advantages of
economies of production
...
Internal economies
...
External economies
Internal economies of scale
Internal economies are those which arise form the explanation of the plant-size of the firm
...
(b) Economies in marketing
(c) Economies in economies
(d) Economies in transport and storage
A
...
Technological advantages
2
...
Economies in marketing;-It facilitates through
1
...
2
...
Economies in large scale distribution
4
...
Managerial economies ;- It achieves through
1
...
Mechanization of managerial function
...
Economies in transport and storage
Economies in transportation and storage costs arise form fuller utilization of transport and
storage facilities
...
Large scale purchase of raw materials
2
...
Lower advertising rate fun advertising media
...
Concessional transport charge on bulk transport
...
Lower wage rates if a large scale firm is monopolistic employer of certain kind of
specialized labour
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Thus External economies of scale are strictly based on experience of large –scale firms or well
managed small scale firms
...
Expansion in the size of the
firms beyond a particular limit , too much specialization, inefficient supervision, Improper
labour relations etc will lead to diseconomies of scale
...
The terms “ Iso-quant” has been derived from the Greek word iso means `equal` and Latin word
quantus means `quantity`
...
An iso- quant curve is locus of point representing
the various combination of two inputs –capital and labour –yielding the same output
...
An
isoquant curve all along its length represents a fixed quantity of output
...
The combinations of A uses one unit of „K‟ and 12 units of „L‟ to produce is20 units
...
Combination
Capital
Labour
Output
A
1
12
20
B
2
8
20
C
3
5
20
D
4
3
20
E
5
2
20
y
A
B
C
labour
D
q3=60units
q2=40 units
q1=20units
x
Capital
The above curve shows the four different combinations of inputs
...
Thus it provides fixed level of output
...
It also implies the diminishing marginal rate of technical substitution
...
The slope of an isoquant indicates the marginal rate of
technical substitution at the point
...
Isoquants have a negative slope:-An isoquant has a negative slope in the economic region or in
the relevant range
...
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2
...
Isoquant cannot Intersect or be tangent to each other
Marginal Rate of Technical substitution (MRTS)
MRTS is the rate at which marginal unit of an input can be substituted for the marginal units of the
other input so that the level of output remains the same
...
This ratio
indicates the slop of Isoquants
Isocost Curve
Isocost curve shows the different combination that a firm can buy with a certain an unit of money
...
k3
capital
k2
k1
O
L1 L2
Labour
L3
x
Usually, the management has to incur expenditure in buying inputs namely - labour , raw –
materials, machinery etc
...
Therefore, it is required to minimize the cost of output that it produces
...
An iso-cost line
is so called because it shows the all combinations of inputs having equal total cost
...
Suppose a firm
decides to spend Rs
...
If one unit of labour costs Rs
...
Similarly, If a unit of capital cost Rs
...
100
...
100, the firm can buy either OL, units of labour or OK, units of capital or
any combination of those two between the extremes‟K1‟and L1
...
The upward isocost curve as represented by K2 L2 and
K3 L3shows higher amounts spent on larger quantities of both K and L
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Optimum Combination of inputs
A profit maximizing firm seeks to minimize its cost for a given output or to maximize the
output for a given total cost
...
Optimum input combination is that which bears least cost
...
This is known as least - cost input
combination
...
The
production function is represented by Isoquant curve and the cost function is represented by Isocost
curve
...
K2
A
Rs
...
100
K1
Capital
C
P
Iq1(40unit)
Iq1(40unit)
Z
B
O
Q
Labour
L1
L2
The figure shows the least –cost combination of capital end labour
...
At this point in the combination is OP of capital and
OQ of labour
...
At the point `z` the isocost line K1,L1, representing
Rs100 is tangent to the isoquant curve Iq1, representing 20units of output
...
The point A or B or Iq1, gives the same output but with
a higher cost combination of inputs K2 L2 representing Rs
...
The point C` is the least cost point of
producing 40 units formed by the intersection of Iq2(40 units)and K2,L2(Rs
...
B
...
The law of variable proportion was first explained by…………
...
Labour is……………
...
3
...
4
...
All inputs become ……………
...
(Each question carries a weightage of One)
1
...
Distinguish between fixed and variable inputs?
3
...
Explain the term Law of return?
5
...
State the tern isoquants?
7
...
Explain the peculiarities of factors of production?
2
...
Distinguish between isoquants and isocosts?
4
...
Discuss the term optimum combination of inputs?
(Each question carries a weightage of One-four)
1
...
Explain the various economies and diseconomies of scale?
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MODULE IV
MARKET STRUCTURES AND PRICE OUTPUT DETERMINATION
Introduction
The determination of price of the product is an important managerial function
...
profit is concerned With the difference between
cost and the revenue
...
Therefore the management always
tries to find out the optimum combination of price and output which offers the maximum profit to the
firm
...
The knowledge of market and market structure with which a firm operates is more helpful in price
output decisions
...
Clark and Clark defines market as that “any body of persons who are in
intimate business relations and carry on extensive transactions in any commodity”
...
Broadly the market forms are classified into two types:1
...
Imperfectly competitive market
Perfect Competition
The term perfect competition is used in wider sense
...
The following are the characteristics of perfectly
competitive market
1
...
Homogeneous product
3
...
All the buyers and sellers in the market have perfect knowledge about the market conditions
...
Perfect mobility of factor of production
6
...
When the first three assumptions are satisfied there exists pure competition
...
In perfect competition ,the demand for the output
for each producer is perfectly elastic
...
Equilibrium Price
The demand curve normally slopes downwards showing that more quantity of commodity will
be demanded at a lower price than at a higher prices
...
Thus the
quantity demanded and quantity supplied vary with price
...
The point so formed is known as equilibrium point and price is known as
equilibrium price
...
B
...
The following are
the market periods based on time- market period, short period and long period
...
Very short period(Market period)
2
...
Long period
Market period or very short period may be only a day or very few days
...
The short period is a period not sufficient to make any changes in the existing fixed plant capacity
...
Long period is a time long enough to adjust the supply to any changes in demand
...
Price determination Under perfect competition
In perfect competition the market price of a commodity is determined by its demand and
supply
...
It can be explained through the following diagram
...
Demand
and supply curves slopes in opposite direction
...
In this figure , the point E determines the equilibrium price
and OQ is the equilibrium quantity
...
So MN will be excess supply
...
It the firm
can minimizes the price, the profit will be low
...
At the point of equilibrium, there are two conditions to be satisfied
...
B
...
Under perfect competition ,the following equations are satisfied
...
The equations can be satisfied with the following diagrams
MC
Y
AC
Price
U
D
O
S
X
Quantity
When the firm is OS quantity of goods, the MC curve cuts the AC curve at its lowest
...
Thus the price OU is equal to the marginal
cost(ST)which is again equal to average cost (ST)
...
During the Market period
In very short period ,supply is inelastic ,thus the price depends on changes in demand
...
Y
D1
S
D
D2
P1
P
P2
D1
D
D2
O
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In the above diagram, SP is the supply curve
...
Here DD is the demand curve
...
The point of equilibrium is at
„S‟ so the equilibrium is OP
...
If the demand increases to D1D1, the price will increase from OP to OP 1 and vice versa ,ie, if the
demand decreases to D2D2 , the price will decrease to OP2
...
The seller does not sell the goods if the price is
low
...
The curve will be curved at beginning ;then it will
become a straight line
...
During short period
In this period ,the firm can make slight changes in their supply of goods without changing the capacity
of plant
...
At point „E‟ the demand curve
equals the supply curve ,the equilibrium price is OP
...
But the
quantity will be decreased from OQ to OQ2
...
A firm gets maximum profit where MC=MR
...
Y
S
D
D1
P
E
P1
C
Price
D
D1
S
O
Q1 Q
X
Quantity demanded and supplied
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In the above diagram, it can be revealed that the price is determined by the industry OP
...
In the case of a firm, MR=AR, thus demand
=AR=MR=price
In the long run
In the long run , the firms in the industry are eager to get super normal profits
...
Long run Average Cost (LAC) and Long run Marginal Cost
(LMC) are to be taken in to consideration
...
(1) DD is the long run
...
The price is determined at OP
...
At this point
...
B
...
In brief, monopoly is a market situation in which there is only
one seller or producer of a product for which no close substitution is available
...
The monopolist can fix price
of his product and can pursue an independent price policy
...
For ex:- electricity , water supply companies etc
...
One seller and a large number of buyers
...
No close substitutes for the product
...
Monopolist is not the price taker and the price maker
...
Monopolist can control the supply
...
No entry of new firm to the market
...
Firm and industry are the same
Causes of Monopoly
1
...
Exclusive ownership or control over the raw materials
...
Economies of large scale production
4
...
Price Determination under Monopoly
A monopoly firm has complete control over the entire supply
...
It can sell more if it cuts down its price
...
As the single firm constitutes the
industry the demand curve of the monopoly firm and the industry will be the same
...
Since average revenue falls when more units of output are sold marginal
revenue will be less than average revenue
...
AR curve
and it falls below AR curve
...
He goes on producing so long as additional units add more to revenue
than to cost He will stop at that point beyond which additional units of production add more to cost than
to revenue
...
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Short Run Monopoly Equilibrium
The monopolist will be in short run equilibrium where the output having MR equal MC
Y
price/cost
MC
P
P1
T
AC
L
MR
O
AR
M
X
Output
In the following figure the monopolist will be in short run equilibrium at output OM where MR is
equal to the short run marginal cost curve MC
...
The total profit is equal to product of profit per unit
with total output
...
In the figure the long run equilibrium of
the monopolist will be at the out put where the long run marginal cost curve MC Intersects the
marginal revenue curve MR
Y
LMC
P
P1
LAC
Price cost
T
MR
O
Out put
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The shaded rectangle `PP`LI ` shows the long run monopolist profit
...
If the cost is at
an increasing trend
...
This will help him to make
maximum profit
...
Under perfect competition there are many sellers but in the case of monopoly , there is only one
seller
2
...
But in
the case of Monopoly individual seller controls the supply
...
Products are identical in the case of perfect competition, but there is only one product in the case
of Monopoly
...
Under perfect competition, there are free entry and exit of firms
...
5
...
6
...
Monopolistic Competition
In the present World market, it can be seen that there is no monopoly and there is no real competition
...
This situation is generally known as Monopolistic competition
...
E
...
The products of the firms under monopolist competition , are
mainly close substitutes to each other
...
The following are the important features of Monopolistic Competition
...
There are large numbers of producers or sellers
2
...
3
...
4
...
5
...
There is no price competition
...
There is lack of knowledge of the market
...
In order to maximize its profit the firm will produce that level of output at which MC=MR if
price is more than MR, there will be abnormal profit
...
New firms will enter the industry and
consequent expansion of output will decrease the price and only normal profit are made by the
firms
...
Then the
equilibrium output will be at AC and MC=MR
...
B
...
(Total cost=Total Revenue)
Difference between Perfect Competition and Monopolistic Competition
Perfect Competition
Monopolistic Competition
1)Products are identical
...
3) Large Number of buyers and sellers
...
5) Selling cost has an important role
...
7) Demand curve is horizontal
7) Demand curve is downward sloping
8)AR,
...
price = demand = AR=MR
Oligopoly
Oligopoly is a situation in which there are so few sellers that each of them is conscious of the
results upon the price of the supply
...
According
to J
...
Further ,they may produce homogeneous or differentiated
products
...
B
...
It has the following features:
1
...
2
...
3
...
4
...
5
...
6
...
There is an element of Monopoly
Price Determination Under Oligopoly
Pricing many be in condition of independent pricing ,Pricing under price leadership and pricing under
collusion
...
An oligopolist always guesses about his competitors reaction
...
The
assumption behind the kinked curve is that each oligopolist will act and react in a way that keep
condition tolerable for all the members of the industry
...
But some times, If one increases the price,
the other will not increase the price
...
Firms usually do not
change their price in response to small changes in costs
...
e(i) the relatively elastic portion of the
demand curve and(ii)the relatively inelastic portion of the demand curve
...
B
...
The price prevailing in the market is OP and the
firm produces OQ output
...
D, M is the relatively elastic of the demand curve and MD Is the
relatively inelastic portion
...
Pricing under Price Leadership
The price leadership means the leading firm determines the price and others follow it
...
The large firm , who fixes the price , is known as the price maker and the firms, who follow it
are known as price –takers
...
They are :
1
...
2
...
3
...
4
...
Price -Output determination Under Price Leadership
In order to determine the price and output under price leadership
...
They are,
1
...
Product are identical
The following diagram will give the clear picture of price output determination
...
B
...
By analysing this diagram it can be known that the firm L will fix at point E2 , where MC=MR
...
Pricing Under Collusive Oligopoly
The term Collusion means `to play together`
...
It is common sales agency formed to
eliminate competition and fix such a price and output that will maximize profit of member firms
...
The following diagram will give the idea more
clear or to make an assumption that there are only two firms viz
...
Firms S
Firms T
Industry
MC
MC1
MC
P1
P2
C1
ac1
e1
ac2
C2
E
C2
MR PD=AR
O
Q1
Figure 12
o
Figure13
Q2
O
Q X
Figure13
In the above diagram, MC denotes the marginal cost curve of industry and MC1 and
MC2 are the MC for the firm S and T
...
The industry is in
equilibrium at point E and equilibrium output is OQ and the price is OP
...
The share of output of each firm will be
obtaining by drawing a parallel line through E to the X axis
...
OQ1and OQ2 determine the market share of firms and Firm T respectively Here , we can say that ,
OQ1+OQ2=OQ, OP1+OP2=OP
Price Discrimination
A monopolist is in a position to fix the price of his product
...
A monopolist is able to charge different price for his products to the different
customers
...
According to Mrs
...
This is also known as differential pricing
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Types of Price Discrimination
1
...
2
...
3
...
There must be more than one separate market
2
...
The market should be such that no buyer of the market may enter the other market and vice
versa
Dumping
When monopolist works in home market as well as foreign market, he is able to discriminate the
price between these two markets
...
This practice is
known as `Dumping` or `price dumping `
...
B
...
It is the expenses incurred in the production of
goods
...
Thus
it includes all expenses from the time the raw material are bought till the finished products reach the
wholesaler
...
The cost concept which are relevant to business operation and
decision can be grouped on the basis of their propose under two overlapping categories:
1
...
Concept used in economics analysis of the business
Types of Cost (or Cost Concepts)
There are several types of costs( or cost concepts)
...
For example , money payments made on
wages and salaries to workers and managerial staff, payments for raw materials purchased, expenses
on power and light ,insurance ,transportation ,advertisement ;and also payments made on the purchase
of machinery and equipments etc
...
Money cost is also called
nominal cost
...
It is the next best
alternative sacrificed in order to obtain that product
...
Opportunity Cost: Opportunity cost refers to the cost of foregoing or giving up an opportunity
...
It implies the income of benefit foregone because a certain course
of action has been taken
...
A man who marries a girl is
foregoing the opportunity of marrying another girl
...
She cannot do both the jobs at the same time
...
Likewise , if an old building is proposed to be used for a
business, where rent of the building is the opportunity cost
...
The opportunity cost concept plays an important role in managerial decisions
...
It is also useful in fixing the price of an output
factor
...
Sunk Cost : Sunk costs are those which have already been incurred and which cannot be changed
by any decision made now or in the future
...
Incremental cost: These are additional costs incurred due to a change in the level or nature of activity
...
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Explicit Cost: Explicit costs are those costs, which are actually paid (or paid in cash
...
Implicit Cost: Implicit costs are those costs, which are not paid in cash to anyone
...
These are the costs, which the
entrepreneur pays to himself
...
Implicit costs are also known as imputed costs or hypothetical costs
...
Thus , accounting costs are explicit costs
...
Since all the expenses on production are in money terms, the accounting costs are money costs or
nominal costs
...
Thus it includes the payment for factors of
production(that is rent, wages etc
...
)
Difference between Accounting Cost and Economic Cost
Accounting cost means the expenses incurred by the firm on production and sale of goods or service
...
For example, payment made for wages, raw materials, fuel,
power, building etc
...
Accounting cost is the money paid for contractual
payments
...
It
is the explicit cost
...
Implicit cost includes rent charged on owned premises, interest charged on owned capital, wages paid to
entrepreneur etc
...
Accounting cost includes only
explicit costs which are recorded in the books of account
...
Thus the economist‟s concept of cost is more comprehensive as compared to accountant‟s
concept of cost
...
Economic costs are used
for decision-making
In short, accounting costs involve only cash payments made by the entrepreneur
...
Cost incurred by a society in terms of resources used in the production of a commodity is
known as social cost of production
...
Social costs include not only the cost borne by the owners of a business(or producers) but
also the cost passed on to the society
...
Pollution caused while producing a
commodity imposes a social cost on those residents who suffer ill health
...
A cost that is not borne by the firm but is incurred by
others in the society is called external cost
...
Thus, social cost is the total cost of the society on account
of production of a commodity
...
Take another example
...
B
...
This is social cost
...
In short social
costs are those costs ,which are incurred by the society in producing commodities and services
...
Private Cost of Production(Private Costs)
Private cost are the costs incurred by a firm in production a commodity or service
...
Private costs include both explicit cost and
implicit cost
...
These
do not include the effect of the produced commodity on the society
...
But
social costs are those costs , which are incurred by the society in producing commodities or services
...
Private costs include both explicit and implicit
costs
...
The concept of social cost enables to understand the social implication of the utilization
of scarce resources among the different sections of the society
...
Fixed and Variable Cost :Fixed Cost: Fixed cost are those costs which do not vary with the volume of production
...
Even if the production is zero, a firm
will have to incur fixed costs
...
The
fixed costs are also called supplementary costs, capacity costs or period costs or overhead costs
...
If
the volume of production increases, average fixed cost will decrease
...
Thus, there Is an inverse relationship between fixed costs
and quantity of production
...
Total fixed cost curve
and average fixed cost curve are shown below :
TFC
TFC
price
AFC
pice
Output
AFC
Output
From the above graph it is clear that the total fixed cost curve is horizontal to the OX axis
...
This implies that as the output
increases , the average fixed cost falls
...
B
...
When the output
increases, variable cost also increases
...
Thus , there is a direct relationship between variable cost and volume of production
...
Examples are materials, wages, power,
stores etc
...
It includes all the
payments and contractual obligations made by the firm together with the book cost of depreciation on
plant and equipment
...
The
opportunity cost includes the expected earnings from the second best use of the resources,or the market
rate of interest on the total money capital and also the value of the entrepreuners own services which are
not charged for in the current business
...
Total cost, Average cost and Marginal cost
Total cost means the sum of total fixed cost and total variable cost
...
That is total cost divided by number of units produced
Average cost=total average fixed cost+total average variable cost
Marginal cost is the additional cost to total cost when an additional unit is produced
...
Output
may vary by changing the variable factors only
...
Thus long run costs are those costs which vary with output when all
input factors(fixed and variable) are variable
...
In other words it is the money value of
output sold in the market
...
Types of revenue
Mainly there are four main concepts of revenue
1
...
Average revenue
3
...
Incremental revenue
Total revenue means the product of price of the commodity to the total quanity of outputs produced in
a current business period
...
Marginal revenue is the additional revenue to total revenue when an additional unit is
produced
...
B
...
It is the difference between the new total
revenue and the existing total revenue
...
The formula for measuring incremental revenue is as follows:
IR = R2-R1
Where, IR = Incremental revenue
R2 = New total revenue
R1 = Old or existing total revenue
Suppose the present volume of production is 50000 units and the selling price is Rs
...
The
existing total revenue is Rs
...
e
...
Suppose the firm has decided to increase the
production to 75000 units
...
2
...
Then
the total revenue (new) would be Rs
...
e
...
5)
...
37500 (i-e1,87,500-1,50,000)
...
37,500
...
It may be noted that incremental revenue will result not from change in price
alone but from any decision alternative
...
Money cost are also known as-----------------------?
2 -----------Costs do not vary with the volume of production ?
3
...
When the marginal revenue is---------------total revenue is maximum ?
5
...
Define sunk Cost ?
2
...
Define fixed cost ?
4
...
What are Social costs ?
6
...
Distinguish between marginal cost and incremental cost ?
2
...
State the relation ship between TC, AC and MC ?
4
...
B
...
Formulating price policies and setting the price are the most important aspects of managerial
decision making
...
Again, it is
the most important device a firm can use to expand the market
...
If it is too low, his income may not cover costs, or at best, fall short of
what it could be
...
If it charges
too little, it will sacrifice profits
...
Meaning of price
...
In other words, it is the exchange value of a
product or service in terms of money
...
To the buyer, price is
the sacrifice of purchasing power
...
Price is very important to both the buyer and the seller
...
Buyers and sellers
...
e
...
All these parties also exercise their influence in
price determination
...
Internal Factors:
These are the factors which are within the control of the organization
...
1
...
2
...
Objectives may be maximum sales, targeted rate of return, stability in prices, increase market share,
meeting or preventing competition, projecting image etc
...
Organizational factors: Internal arrangement of the organization
...
4
...
Since these are interconnected, change in one element will influence
the other
...
Product differentiation: One of the objectives of product differentiation is to charge higher prices
...
Product life cycle: At various stages in the Product Life Cycle, various strategic pricing decisions
are to be adopted, eg
...
Usually firm charges lower price and in growth stage
charges maximum price
...
Characteristics of product: Nature of product, durability, availability of substitute etc
...
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External Factors
...
The following are the main external factors
...
Demand: If the demand for a product is Inelastic it is better to fix a higher price and if demand
is elastic, lower price may be fixed
...
Competition: Number of substitutes available in the market and the extent of competition and
the price of competition etc
...
3
...
Manufacturer would desire that middleman
should sell the product at a minimum mark up
...
General economic conditions: During inflation a firm forced to fix a higher price and in
deflation forced to reduce the price
...
Government Policy: While taking pricing decision, a firm has to take into consideration the
taxation policy, trade policies etc
...
6
...
Pricing Policies
...
Price setting is a complex problem
...
Price policies provide the guidelines within which pricing strategy is formulated and implemented
...
Price policies are
those management guidelines that control the day to day pricing decision as a means of meeting the
objectives of the firm such as maximization of profit, maximization of sales, targeted rate of return,
survival, stability of prices, meeting or preventing competition etc
...
Selecting the target market or market segment on which marketer would concentrate more
...
Studying the consumer behavior and collecting information relating to target market selected
...
Studying the prices, promotion strategies etc
...
4
...
5
...
6
...
Objectives of pricing policy
...
Before determining the price itself, the management should decide the objectives
...
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1
...
2
...
3
...
4
...
5
...
6
...
7
...
8
...
Profit is less important than survival
...
Prestige and goodwill:
goodwill of the firm
...
Achieving product –quality leadership: Some Companies aim at establishing product quality
leader through premium price
...
1
...
3
...
5
...
7
...
Cost Plus pricing
...
Going rate pricing
...
Follow up pricing
...
Marginal cost pricing
...
1
...
Under this method, the price
is fixed to cover all costs and a predetermined percentage of profit
...
This method is also known as margin
pricing or average cost pricing or full cost pricing or mark up pricing
...
2
...
Under this method, the cost is added with the
predetermined target rate of return on capital invested
...
This is also called as
rate of return pricing
...
B
...
Marginal cost pricing: Under the marginal cost pricing, the price is determined on the basis of
marginal cost or variable cost
...
4
...
This method is called discriminatory pricing
or price discrimination
...
5
...
I
...
, under this method a firm charges the prices according to what competitors
are charging
...
This
method is also called acceptance pricing or parity pricing
...
Customary pricing: in the case of some commodities the prices get fixed because they have
prevailed over along period of time
...
In short the prices
are fixed by custom
...
It is also called
conventional pricing
...
Follow up pricing: this is the most popular price policy
...
If the competitors reduce the price of the
product, the firm also reduces the price of its product
...
8
...
In this type of price leadership,
there is no leader firm
...
This is followed by other firms in the industry
...
On the basis of a formal or informal tacit agreement, the firms in the
industry accept a firm as price leader who may act firstly upon the environmental or market changes
...
(Methods and strategy)
In pricing a new product, generally two types of strategies are suggested
...
Skimming price strategy
This is done with a basic idea of gaining a premium from those buyers who always ready to pay
a much higher price than others
...
Thus skimming price refers to the high
initial price charged when a new product is introduced in the market
...
B
...
D
...
F
...
When the demand of new product is relatively inelastic
...
When the buyers are not able to compare the value and utility
...
To recover early the R&D and promotional expenses
...
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2
...
Since the price is lower, the product quickly penetrates the market,
and consumers with low income are able to purchase it
...
Product has high price elasticity in the initial stage
...
The product is accepted by large number of customers
...
Economies of large scale production available to firm
...
Potential market for the product is large
...
Cost of production is low
...
To introduce product into market
...
To discourage new competitors
...
Most of the prospective consumers are in low income class
...
Pricing strategy is a
policy determined to face a specific situation and is of temporary nature
...
Following are the important pricing strategies
...
Psychological pricing: Here manufacturers fix their prices of a product in the manner that it
may create an impression in the mind of consumers that the prices are low
...
g
...
99
...
This is also called odd pricing
...
Mark up pricing
...
When the
goods are received, the retailers add a certain percentage of the whole saler‟s price
...
Administered pricing: Here the pricing is done on the basis of managerial decisions and not on
the basis of cost, demand, competition etc
...
Other pricing strategies: Geographical pricing, base point pricing, zone pricing, dual pricing,
product line pricing etc
...
Role of Cost in Pricing
Most of the wholesale and retail organizations add some percentage of profit or mark up total
cost per unit to arrive at selling price
...
they determine price and output on the basis of full average cost
of production
...
In the short run the firm may
not cover the fixed cost but it must cover at least variable cost
...
if the entire cost is not recovered, the firm will incur losses, and the firm must stop their production
...
If the cost increase price also increases
...
e
...
Cost also
determines the profit margin at various level of output
...
In some cases demand occupies
a vital role than cost
...
We know as
per law of demand, demand and price have inverse relationship
...
Similarly to decrease the demand the firm has to increase the price
...
If the demand for
the product is elastic, the firm can fix lower price
...
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Consumer Psychology and Pricing
While fixing the price of product, the management should give importance to consumer psychology
...
Some consumer may buy
a product of high quality even though the products are highly priced
...
If the price of product is less, consumer will think that such
product is of low quality
...
If the price is too low the consumers think that the goods
are of inferior quality
...
The important elements that influence the consumer
psychology are; price of the product, after sales service, advertisement and sales promotion, personal
income, fashions
...
So in case of price determination, the consumer psychology must given due weightage
...
B
...
Economic activities faced fluctuations at more or less regular intervals
...
A period of prosperity was generally followed by a period of
depression
...
Business cycle simply means the whole course of business activity which
passes through the phases of prosperity and depression
...
prosperity and depression
...
A movement in one direction tends automatically to
generate a movement in the opposite direction
...
The period of business prosperity contains within itself the seed of the coming period
of depression
...
At the peak of the boom recession grips the economy which soon slides into depression
...
viz
...
The Business cycle influence business decision
...
The period of prosperity promotes business
...
Likewise, a period of depression slackens business
...
This helps to take advantage of the chance ahead or to reduce the chance of heavy
losses to the firm
Phases of business cycle
Boom
This is also known as prosperity phase
...
This attracts more and more investors
...
More and more new machines are made use of the business of the
capital goods industry also shoots up
...
Additional
workers are employed at higher wage rate
...
The fixed income group on the salaried class find it
difficult to cope with this increase in prices
...
The demand is now more or less stagnant or it even
decreases
...
Recession
Once the economy reaches the peak- the course changes
...
The supply now
exceeds demand
...
They are compelled to
give up the future investment plans
...
A business even cuts down its existing business
...
Bankers insist on repayment
...
Desire for liquidity increase all around producers are compelled to
reduce price so that they can find money to meet their obligations Consumers who expect a still further
decline in prices postpone their consumption Stock goes on piling up
...
The failure of one firm affects other firm with whom it has business connections
...
This phase of the business cycle is known as the Recession
...
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Depression
Underemployment of both men and material is the characteristics of this phase
...
Producers are compelled to see their goods at a price which will not even cover
the full cost
...
As a result workers are thrown out
...
The demand for bank credit is at its lowest which results in idle funds
...
The firms that cannot pay of their debts are wound up
...
Pessimism prevails in the economy the less confident investors are not ready to take up new investment
projects The aggregate economic activity is at its bottom
...
Depression contains in itself the gems of
recovery
...
As the prices are at its lowest the
consumers, who postponed their consumption expecting a still further fall in price , now starts
consuming
...
As demand increases the stock of goods become insufficient
...
Investment pick up
...
Increased income increases demand, resulting in rise in prices, profits investment,
employment and incomes
...
Stock
markets become live thus hastening the revival
...
Bank
loans and demand for credit starts rising
...
Characteristics of a business cycle
1
...
The upward and downward movements tend to occur at all the same period in
all industries
...
When
industry pick up to provides more employment , more income etc
...
This help other firms also to prosper
...
A business cycle is a wave-like movement
...
The period of prosperity and depression can be
3
...
The various phases are repeated is followed by
depression and the depression again in followed by a boom
...
B
...
Business cycles are cumulative and self –reinforcing in nature
...
Once booms starts it goes on growing till forces
accumulate to reverse the direction
...
There can be no indefinite depression or eternal boom period
...
The boom, when it reaches its peak, turns to recession
...
Business cycles are pervasive in their effects
...
Depression or prosperity felt in one part of the economy makes its impact in other
part also
...
The mechanism of
international trade makes the boom or depression in one country shared by other countries also
...
Presence of a crisis
...
The downward movements are not
symmetrical
...
Types of Business Cycle
Prof
...
Major and Minor Trade Cycles: Major trade cycles are those the period of which is very large
...
Prof
...
Two or three minor cycles occur
during the period of a major cycle
...
2
...
period of such cycle range from 15 to 20 years
3
...
It was discovered by a Russian economist
Kondratief
...
Schumpeter distinguished 3 types of trade cycle as follows:
1
...
2
...
5 years duration
...
Very long Kondratief Wave: It takes more than 50 years to run its course
...
They are internal and external
...
External forces are elements outside
the normal scope of business activity and include population growth ,wars, basic changes in the
nation‟s currency and national economic policies
...
Important causes giving birth to business cycle may be summarized as follows:
1
...
Monetary disequilibrium
3
...
Under consumption or excessive saving
5
...
Dealings of entrepreneurs
7
...
Seasonal fluctuations
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Control of Business Cycle
The business cycle leads to greater unemployment and poverty
...
Monetary Policy
Monetary policy refers to the programs adopted by the central bank to control the supply of money
...
The open market implies the purchase and sale of government bonds and
securities
...
During periods of depression the central bank
purchases government securities which increase the cash supply in the economy
...
The central bank purchase government securities which increase the cash supply in the
economy
...
The central bank may change the bank rate or rediscount
rate
...
When the
central bank increases the bank rate the commercial banks in turn will raise their discount rates for the
public
...
During the depression the bank
rate is lowered which will end up the increased investment
...
When the central bank wants to reduce the credit
creation capacity of commercial banks, it will increase the ratio of the deposits to be held by the
commercial bank as reserve with the central bank
...
Taxation helps to withdraw cash from the public
...
Taxes should be reduced during the depression will stimulate
private sector
...
The fiscal policy of the government to regulate purchasing power to control business cycle
is known as counter the cyclical fiscal policy
...
The budget surplus can be
used to eliminate previous deficits
...
The monetary policy proves more effective to control
boom than to depression
...
Business Forecasting
A forecast of sales of depends upon economic forecasts
...
Periods of depression and boom have an influence on the
sales value
...
The businessman should take into consideration the business cycle he is facing so that he can have an
effective forecast of sales
...
Trend projection
A graph showing the actual movement of a series is constructed and the apparent trend of the data on
future is projected(extrapolated)
...
Leading Indices
The‟ Leading Indices‟ refer to certain sensitive series which tend to turn upward or downward in
anticipation of other series
...
It would not be difficult to purchase raw materials in advance if prices are expected to rise
...
B
...
Econometric Models
Econometrics combines Economics and mathematics
...
Econometrics explains past economic activity by deriving mathematical equations that
will express the most probable inter-relationship between asset of economic variable
...
Techniques of Economic Forecasting
There are several methods or techniques of economic and business forecasting, Important methods may
be briefly discussed as follows:
1
...
This method is not based on any scientific approach
...
This method includes such
techniques as tossing the coin, simple correlation and even some other simple mathematical
techniques
...
b) It is less costly
c) It is suitable small firms
Disadvantage of Naïve Method
a) It is not a scientific method
...
Survey Techniques:- One of the simplest forecasting device is to survey business firms or
individuals and to determine what they believe will occur is survey techniques
...
These are helpful in
making short-term forecasts
...
Advantages
a) This method is simple and less costly
...
B
...
Expert opinion method
It is a qualitative technique
...
4
...
Here actual data are
presented on a graph paper and forecasts for the future are prepared on the basis of analysis of trend of
this data
...
Similiarly it requires
considerable technical skill and experience
...
This method is very cheap and inexpensive
...
Barometric Techniques
In this method present events or developments are used for predicting the future
...
They are
leading, lagging and coincident indicators
...
This method is the most complex and scientific one
...
Econometrics is the combination of “econo” and “metrics” which means measurement of economic
variables
...
It predicts the future activity on past economic activity by using
mathematical and statistical techniques
a) These methods are more reliable
...
The model can modified to improve
future forecasts
...
d)These methods have the ability to explain economic phenomena
...
This method enables the forecaster to trace the
effects of increases in demand for one product to other industries
...
This, in turn, will lead to an
increase in the demand for steel, glass, plastics, rubber and upholstery fabric
...
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Self check questions
Fill in the blanks
...
In…………
...
2
...
The firm charges price in tune with the industry‟s price is called………
4
...
pricing is done on the basis of managerial decisions, not on the basis of cost, demand
etc……
...
2
...
4
...
6
...
8
...
2
...
4
...
Mention various method of pricing?
What are the objectives of pricing policy?
What is the role of cost and demand factors in price determination?
Explain the pricing strategies of new products?
What is the role of consumer psychology in pricing?
Essay type (Weightage -4)
1
...
Explain important methods of pricing?
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